The economies of poorer states Bihar and Bengal shrunk according to the new series while those of southern states Karnataka and Kerala saw a huge jump
Most of the relatively prosperous states such as Delhi, Kerala and Karnataka saw a further boost to their GSDP numbers when new figures were published
India’s new methodology of estimating the gross domestic product (GDP) has re-written the fortunes of states, a Mint analysis of the gross state domestic product (GSDP) numbers show. These changes have enormous implications for the borrowing limits of states (their fiscal deficit thresholds mandated by law), and on the devolution of resources to states by the Finance Commission.
The advisory council of the 15th Finance Commission (FC) is set to discuss these issues on Thursday, two people with direct knowledge of the matter said. Both declined to be named. The introduction of a new database (MCA-21) and the adoption of other methodological changes meant that India’s new GDP series has continued to face questions from both officials and independent researchers ever since it was introduced in 2015 (See “How India’s statistical system was crippled", 8 May 2019). The impact on the states has been far more.
An analysis of the aggregate GSDP of states for the years for which the common data is available for both the old and the new series (FY12-FY14) shows that several states saw huge swings in fortunes after the introduction of the new series (see chart 1).
Among the 20 major state economies, Bihar and West Bengal saw their economies shrink even as others expanded. The increase was, however, far from uniform with several poorer states such as Madhya Pradesh, Rajasthan and Odisha losing out from this change. The big exceptions in this list were Jharkhand and Assam, which saw a sizeable increase in their state economies.
Most of the relatively prosperous states such as Delhi, Kerala and Karnataka saw a further boost to their GSDP numbers when the new figures were published. Haryana, Gujarat and Punjab were the exceptions among the prosperous states as they saw only a small increase in the size of their economies.
The biggest contrast was between Andhra Pradesh (whose GSDP barely moved up) and Telangana (which saw a big jump in GSDP). Although this is partly owing to the loss of Andhra’s capital and economic hub, Hyderabad, to Telangana, the new methodology may also have played a role. While the national GDP figures were released by the Central Statistics Office (CSO) in 2015, the new GSDP figures (base year 2011-12) were published only in 2016. Some of the gainers of this windfall were quick to realize what it meant for their borrowing limits. Under the Fiscal Responsibility and Budget Management Act (FRBM), states are supposed to limit their borrowing to 3% of GSDP. But when the GSDP is inflated, states can spend more in absolute terms without breaching that limit. As pointed out by Ajai Sreevatsan in Mint earlier, Karnataka saw a massive spending binge since 2016, buoyed by the re-estimation of its GSDP. Telangana also seems to have followed a similar approach, with its gross fiscal deficit almost doubling (in absolute terms) between fiscal 2016 and fiscal 2017. However, the extent of increase in its fiscal deficit ratio (as a proportion of GSDP) was much smaller (see chart 2).
Poorer states, however, were hit hard as they had to crimp spending to meet their deficit targets. “The change to the new GSDP series has led to a harder budget constraint compared to earlier for poorer states such as Bihar and Madhya Pradesh," said Ravindra H. Dholakia, an Ahmedabad-based economist and member of the monetary policy committee of the Reserve Bank of India. Dholakia was the first to warn about the problems in the new GSDP numbers in a 2017 research paper co-authored with Manish Pandya of the Gujarat directorate of economics and statistics. “At the other end, there is an unexpected increase in the size of some state economies, which has eased their borrowing constraints."
Some states which have witnessed such windfall gains don’t seem to mind.“There might have been small changes (in methodology) but I don’t think there have been any substantial changes," said a senior finance ministry official from the government of Kerala.
However, according to several economists, the new methodology not only overstates the levels of GSDP but could also inflate their growth rates in each year.
“At the national level itself, the blowing-up of the corporate sector data could lead to an over-estimation when non-reporting companies do not exist," said J. Dennis Rajakumar, director, Economic and Political Weekly Research Foundation. “In case of GSDP estimation, the problems are more serious because of limited information on proxies used to estimate the state-level break-up from the national estimates."
The problem is more acute in the case of services, Rajakumar noted. Dholakia in his paper had warned that the inaccurate estimation of GSDP numbers could be a big headache for the FC which uses these numbers to calculate fiscal ratios. Those fears have come true, with the FC now trying to ‘reconcile’ the data. “Re-estimating GSDP is beyond the Finance Commission’s mandate," said Abhijit Sen, a former member of the FC and the erstwhile Planning Commission. “It has to depend on the CSO for the figures it uses. But it can try and triangulate from different sources to come up with its own projections."
Dholakia, who now heads a committee set up by the Ministry of Statistics and Programme Implementation (Mospi) to re-examine the estimation of state-level and district-level GDP estimates for the next base year revision (base year 2017-18) said that by the time his report comes up, and the recommendations are implemented, the term of the current Finance Commission would be over. The Dholakia committee was set up in June last year, with a term of one year.
“The original term of the committee was too short given the enormity of the task, and the amount of co-ordination required with state and central agencies," said Dholakia. “Besides, we want to be careful to avoid past mistakes."
How the devolution of funds by the FC affects different states also depends on the formula that is being used. If greater weight is given to fiscal performance, poorer states would be penalized. On the flip side, if poverty or the ‘income distance’ metric (which measures the difference between the per capita GSDP of a state and the per capita GSDP of the state with the highest per capita income) receives a higher weight, poorer states could benefit. “Ultimately, it depends on the formula being used," said Sen. “But other than the income distance indicator, everything goes against the poorer states."
To be sure, the GSDP numbers compiled by states and those used by the Finance Commission are not strictly comparable. The numbers used by the finance commission earlier, the ‘comparable GSDP estimates’ would be computed by CSO using a separate methodology. While that methodology is not publicly available, the tables published by the 14th FC show some discrepancy in the two sets of estimates across states (see chart 3).
However, it is worth noting that the magnitude of those discrepancies is far lower than the discrepancies produced by the base-change exercise of CSO. “The issues of inter-state comparability of GSDP figures were far more severe before the mid-1980s," said Dholakia. “Since then, the CSO estimates and state estimates have converged for most states. With the new series, the GSDP numbers have become distorted for several states."
The problem with the new series is a structural one, said Rajakumar. “Before implementing the shift from the establishment approach to the enterprise approach, which necessitated the use of the MCA-21 database, CSO should have waited till all relevant disaggregated information was made available by MCA," he said. “In the absence of such details, we do not know clearly how much is being produced in which sector, and in which state." The shift to the enterprise approach was part of a broader move to comply with the System of National Accounts (SNA) 2008 norms.
But Rajakumar argued that India’s statisticians could have liaised with the UN statistical agencies to avoid this shift in a hurried manner. “Even earlier, SNA had recommended the use of GDP at market prices as a measure of GDP," he said. “But we stuck to estimating GDP at factor cost for years." There should be an independent committee to reconstruct the old series for the next few years, in consultation with statisticians from multilateral institutions such as the International Monetary Fund and World Bank, said Rajakumar.
“Till a cleaner and more detailed corporate database is available to CSO, we should stick to the old approach," he said.